Earned Income Tax Credit Recipients: Income, Marginal Tax .../media/richmondfedorg/publications/... · Earned Income Tax Credit Recipients: Income, Marginal Tax Rates, Wealth, and

Economic Quarterly—Volume 96, Number 3—Third Quarter 2010—Pages 229–258

Earned Income Tax CreditRecipients: Income,Marginal Tax Rates, Wealth,and Credit Constraints

Kartik B. Athreya, Devin Reilly, and Nicole B. Simpson

T he Earned Income Tax Credit (EITC) has become the federal govern-ment’s largest cash-assistance program for low-income families, mak-ing it the centerpiece of anti-poverty programs in the United States.

Approximately 15 percent of households nationwide now qualify for the EITC(Hoffman and Seidman 2002). Moreover, unlike other government programs,the EITC is administered through the income tax filing process, which re-duces any potential stigma associated with the program, and aids in ensuringhigh participation rates (Smeeding, Phillips, and O’Connor 2000). Accordingto Eissa and Hoynes (2009), approximately $43 billion was allocated to 22million families in the United States in 2007 through the federal EITC. Thiscompares to $16.5 billion that was spent on more traditional welfare programs,such as Temporary Assistance for Needy Children (TANF).

The EITC is designed to augment income while encouraging work: Thetax credit increases with earnings for low levels of household income. Thesize of the credit is such that, for low-income households that qualify, theEITC is a negative tax on earnings that often constitutes a significant portionof after-tax wage income. The EITC does appear to have been successfulin both helping the working poor get out of poverty and encouraging work.Neumark and Wascher (2001), Ziliak (2006), and Simpson, Tiefenthaler, andHyde (2009) provide evidence that the combined federal and state EITC helps

Athreya is a senior economist at the Federal Reserve Bank of Richmond. Reilly is a formerresearch associate at the Federal Reserve Bank of Richmond. Simpson is an associate professorof economics at Colgate University. The views expressed in this article are those of the authorsand not necessarily those of the Federal Reserve Bank of Richmond or the Federal ReserveSystem. E-mails: [email protected]; [email protected].

230 Federal Reserve Bank of Richmond Economic Quarterly

families rise above the poverty line. In fact, the EITC has been estimated tohave helped five million people out of poverty in 2005, including 2.6 millionchildren.1 Hotz and Scholz (2000) find that, compared to other poverty-reduction programs, the EITC is effective in raising the standard of living forlow-income households, while keeping administrative costs relatively low.

However, the EITC phases out with earnings, until eventually a householdno longer qualifies for it. The structure of the phase-out means that familiesearning more than $41,000 in 2008 will not qualify for the EITC, while allthose earning less will. In addition, the credit targets families with children,and increases in generosity with the number of children in the household. Forexample, households with two or more children (in tax year 2008) earning$15,000 could qualify for up to $4,824 in federal earned income credits. Incontrast, a childless single filer can receive only one-tenth of this amount, or atmost $438. Thus, for those households with children and low earned income,the full refundability of the EITC ensures that it will represent a substantialaddition to income.

In this article, we summarize the details of the EITC and describe thepopulation of EITC recipients. Using Current Population Survey data, we es-timate earnings and EITC benefits received by EITC recipients at various ages.Naturally, we find that because of the eligibility requirements, the earningsof EITC recipients are relatively similar across the age of recipients, whichmakes them differ systematically from non-recipients of the same age—whoseearnings show a more pronounced “hump shape” with age. We then discusshow the EITC affects marginal taxes in the United States and summarize itstheoretical and empirical effects on household labor supply decisions. Fi-nally, we compare wealth levels of EITC recipients with non-recipients usingdata from the Survey of Consumer Finances (SCF), and find significant differ-ences in their wealth distributions, with EITC recipients being substantiallypoorer. The fact that EITC recipients have relatively low wealth levels andlow earnings relative to others in their age group suggests that they may bemore likely to be borrowing-constrained than non-recipients. In fact, we findsome evidence for this in our analysis of SCF data.

1. HISTORY OF THE EITC

In Table 1, we briefly summarize the history of EITC legislation. The EITCstarted as a modest program as part of the Tax Reduction Act of 1975.2 Theprogram was unique among tax credits as it was refundable so that poor fami-lies could utilize its benefits even if they owed little or no taxes. Unlike welfareprograms such as Aid to Families with Dependent Children (AFDC), single

1 Center on Budget and Policy Priorities: www.cbpp.org/cms/?fa=view&id=2505.2 For a more detailed history of the EITC, refer to Hotz and Scholz (2003).

K. B. Athreya, D. Reilly, and N. B. Simpson: EITC Recipients 231

Table 1 History of EITC Legislation

Year Changes to the EITC1975 Introduced temporary “work bonus” called the EITC1978 Made EITC permanent1986 General expansion (largest increase since its inception) and indexed for

inflation; part of the Tax Reform Act1990 General expansion by doubling the maximum credit and increased

eligibility; added separate schedule for families with two or morechildren; part of OBRA

1993 General expansion (larger expansion for families with two or morechildren); added EITC for childless filers; part of OBRA

1997 Provisions made to improve compliance; part of Taxpayer Relief Act2001 Changes to provide marriage penalty relief and promoted simplification;

part of EGTRRA2009 Expansion for families with three or more children and expanded eligibility

for married couples; part of the American Recovery and Reinvestment Act

Sources: Hotz and Scholz (2003); Holt (2006); Tax Policy Center (2009).

parents as well as married couples were eligible for the program. The EITCwent through minor changes in subsequent years, the most important beingwhen it became a permanent provision of the Internal Revenue Code in 1978.

The Tax Reform Act of 1986 indexed the EITC to inflation and liberalizedthe EITC, helping, by some estimates, to remove over six million Americansfrom poverty (Ventry 2000). The Omnibus Reconciliation Act (OBRA) of1990 increased the credit and added separate schedules for families with twoor more children. The largest expansion of the EITC occurred in 1993, as partof the OBRA, in which the EITC was increased by an additional 25 percent.Families with two or more children experienced the largest increase in thecredit, and childless filers could now qualify for the EITC. Both the size of thecredit and the eligible population have grown over time, and were fueled by thepassage of the Personal Responsibility and Work Opportunity ReconciliationAct of 1996, which replaced AFDC with Temporary Assistance for NeedyFamilies (TANF). The United States experienced a 50 percent reduction inwelfare rolls between 1993 and 2000, and Grogger (2004) finds that much ofthe drop is attributed to the EITC and reduction in welfare benefits.

Until 2001, the structure of the EITC was identical for single and marriedfilers. However, as part of the Economic Growth and Tax Relief ReconciliationAct (EGTRRA) of 2001, married couples received larger benefits for largerranges of income levels than single filers. The success of the federal EITC hasled to the development of similar programs in 23 U.S. states and the Districtof Columbia, totaling an additional $2 billion (Levitis and Koulish 2008).


Tabl

e2

EIT

CP

aram

eter

s,Ta

xY

ear

2008

Mar

ried

,M

arri

ed,

Sing

le,

No

Sing

le,

One

Sing

le,

Tw

o+M

arri

ed,

No

One

Tw

o+Q

ualif

ying

Qua

lifyi

ngQ

ualif

ying

Qua

lifyi

ngQ

ualif

ying

Qua

lifyi

ngC

hild

ren

Chi

ldC

hild

ren

Chi

ldre

nC

hild

Chi

ldre

nPh

ase-

InR

ate

7.65

%34

.00%

40.0

0%7.

65%

34.0

0%40

.00%

Phas

e-In

End

s$5

,720

$8,5

80$1

2,06

0$5

,720

$8,5

80$1

2,06

0M

axim

umC

redi

t$4

38$2

,917

$4,8

24$4

38$2

,917

$4,8

24Ph

ase-

Out

Beg

ins

$7,1

60$1

5,74

0$1

5,74

0$1

0,16

0$1

8,74

0$1

8,74

0Ph

ase-

Out

Rat

e7.

65%

15.9

8%21

.06%

7.65

%15

.98%

21.0

6%E

ligib

ility

Cei

ling

$12,

880

$33,

995

$38,

646

$15,

880

$36,

995

$41,

646

Sour

ce:

Min

neso

taH

ouse

Res

earc

hD

epar

tmen

t.


Table 3 EITC Calculation by Phase

Phase EITCPhase-In = Phase-In Rate * IncomePlateau = Maximum CreditPhase-Out = Maximum Credit − Phase-Out Rate * (Income − Income Where

Phase-Out Begins)

Finally, the American Recovery and Reinvestment Act of 2009 increasedthe credit for families with three or more children and expanded eligibility formarried couples. Families making up to $48,250 in annual earnings can nowqualify for the tax credit, with the maximum credit as high as $5,657 for afamily with three or more children. This EITC expansion is expected to helpan additional 650,000 households and 1.4 million children.3

2. STRUCTURE OF THE EITC

The EITC acts as an after-tax wage subsidy for low-income workers and de-pends on earned income, number of children, and marital status.4 Earned in-come includes wages, salaries, tips, and other employee compensation; unionlong-term disability benefits received prior to minimum retirement age; andnet earnings from self-employment. However, it does not include social se-curity benefits, unemployment compensation, welfare benefits, scholarships,worker’s compensation benefits, or pension/annuity income.

The EITC is structured in three phases: In the phase-in period, the creditincreases with earnings; in the plateau period, the credit reaches a maximumand levels off; and in the phase-out period, the credit falls as the claimant’searnings rise. At the eligibility limit, the household earns no EITC. The EITCis separated into different levels for claimants with no children, those withone child, and those with two or more children. There are also differenttax credits for different types of filers: Married couples filing jointly areeligible for slightly higher credit amounts in the phase-out period than singlefilers and have slightly larger income eligibility ranges. Table 2 presentsthe details of the EITC for tax year 2008 for different filing statuses (singleor married) and number of children, and includes the maximum credits andearnings limitations. In Figure 1, we plot the amount of federal EITC thatsingle and married households receive across various income levels: singlefilers are depicted by the solid lines, whereas married filers are depicted by

3 Tax Policy Center (2009).4 Many of the poorest families are ineligible for the EITC since their earnings are too low

to qualify and/or they do not have children (Hoffman and Seidman 2002).


Figure 1 EITC Structure by Income, Tax Year 2008

No Children

One Child

Two or More

$4,824

$2,917

$438

Income

EIT

C (

2008$)

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,0000

5,000

4,500

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

Note: Solid line represents single/head of household filers; dashed line represents marriedfilers.

the dashed lines. To calculate the EITC in each phase, we use the equationsin Table 3 along with the EITC parameters in Table 2.

As seen in Figure 1, the EITC significantly varies with the number ofchildren present in a household. Childless filers receive less than one-eighthof the EITC than filers with one child and one-twelfth of filers with two or morechildren. The federal credit can represent up to 34 percent and 40 percent ofincome for filers with one and two or more children, respectively. In additionto the federal EITC, many states supplement, or match, with additional credits.As a result, if the taxpayer lives in a state that offers a state EITC, the total EITC(federal plus state) could be much larger; for example, New York residentsreceive an additional 30 percent of the federal credit. Also interesting is thatthe slope of the EITC function is steeper in the phase-in range than in the phase-out range. That is, an additional dollar of earned income rewards householdsin the phase-in range by giving them a credit, which can range from $0.07(for childless singles) to $0.40 (for married couples with two children). In thephase-out range, an additional dollar of income results in a reduction in the


credit, from $0.07 (for childless singles) to $0.21 (for married couples withtwo children).

The range of eligible income is much larger as the number of dependentchildren rises. As of 2008, married households with two children earningless than $41,626 qualify for the EITC, compared to $15,880 for childlesscouples. The maximum EITC does not vary with marital status, but the incomeeligibility ranges are slightly larger for married couples. In addition, therange of eligible income is much larger in the phase-out range so that morehouseholds are in the phase-out range than in the phase-in range. In fact,recent evidence suggests that married households are more likely to be inthe phase-out range than singles, since they are more likely to have higherhousehold income.

3. LABOR MARKET CHARACTERISTICS OFEITC RECIPIENTS

Using Current Population Survey (CPS) data from 2008, we analyze the labormarket characteristics of EITC recipients and compare them to non-EITCrecipients. We create household-level observations by matching individualswho are married to each other, and we restrict the sample to households wherethe household head is between the ages of 16 and 64 years. Households areclassified into six different types, based on marital status (married or single)and number of children (no children, one child, two or more children). Thisclassification is consistent with the structure of the EITC, as discussed inSection 2. We find that approximately 12.8 percent of households in oursample receive the EITC. Table 4a reports the mean annual wage and salaryincome, education level, and EITC amount for each household type, whileTable 4b reports the fraction of each type in the sample. All of the meansrepresent weighted averages using the household weights supplied by the CPS.It is important to note that 2008 CPS data corresponds to the 2007 tax yearand that the CPS only reports estimated federal EITC and does not includeany state EITCs.

Approximately 60 percent of EITC recipient households are single, withan equal distribution of single households having zero, one, and two or morechildren. This contrasts to married couple households, where the majorityof EITC recipient households have two or more children. The amount ofEITC varies significantly across household types. Single households withtwo children receive the most EITC ($2,728), which constitutes the largestshare of their annual income, at 15 percent. Households without childrenreceive much less EITC, constituting only 6 percent of their annual income.


Tabl

e4

EIT

CR

ecip

ient

s

4a:

Lab

orM

arke

tC

hara

cter

isti

csof

EIT

CR

ecip

ient

vs.

Non

-Rec

ipie

ntH

ouse

hold

sM

arri

ed,

Mar

ried

,M

arri

ed,

Sing

le,

Sing

le,

Sing

le,

All

No

Kid

sO

neK

idT

wo+

Kid

sN

oK

ids

One

Kid

Tw

o+K

ids

EIT

CR

ecip

ient

s:M

ean

Hou

seho

ldIn

com

e$1

5,19

4$8

,325

$18,

700

$21,

212

$7,0

24$1

5,76

1$1

7,42

1St

.D

ev.

ofH

ouse

hold

Inco

me

$16,

132

$8,1

00$1

0,59

0$1

1,22

5$5

,894

$9,7

39$1

0,40

9Pe

rcen

tof

Hig

hSc

hool

orL

ess

61.5

%70

.5%

64.1

%68

.5%

60.0

%54

.1%

58.3

%Pe

rcen

tw

ithTw

oE

arne

rs26

.3%

9.6%

24.6

%30

.1%

n/a

n/a

n/a

Ave

rage

EIT

C$1

,782

$495

$1,8

12$2

,623

$423

$1,8

08$2

,728

EIT

Cas

Perc

ent

ofIn

com

e11

.7%

5.9%

9.7%

12.4

%6.

0%11

.5%

15.7

%N

on-E

ITC

Rec

ipie

nts:

Mea

nH

ouse

hold

Inco

me

$47,

235

$68,

549

$83,

372

$94,

271

$23,

696

$32,

125

$31,

723

St.

Dev

.of

Hou

seho

ldIn

com

e$4

9,65

3$6

7,88

4$7

1,05

2$7

9,82

2$3

2,30

5$4

7,99

8$5

1,99

7Pe

rcen

tof

Hig

hSc

hool

orL

ess

39.7

%36

.1%

34.2

%29

.6%

43.4

%46

.6%

48.3

%Pe

rcen

tw

ithTw

oE

arne

rs65

.1%

56.8

%70

.5%

71.3

%n/

an/

an/

a

4b:

Dis

trib

utio

nof

Hou

seho

lds

inth

eC

PS

Mar

ried

,M

arri

ed,

Mar

ried

,Si

ngle

,Si

ngle

,Si

ngle

,N

oK

ids

One

Kid

Tw

o+K

ids

No

Kid

sO

neK

idT

wo+

Kid

sSu

mE

ITC

Rec

ipie

nts:

Perc

ent

ofA

llH

ouse

hold

s0.

59%

1.21

%3.

12%

3.15

%2.

32%

2.45

%12

.83%

Perc

ent

ofE

ITC

Rec

ipie

nts

3.9%

9.6%

26.8

%19

.8%

19.4

%20

.6%

100.

00%

Non

-EIT

CR

ecip

ient

sPe

rcen

tof

All

Hou

seho

lds

14.6

0%7.

91%

12.4

0%46

.26%

3.81

%2.

19%

87.1

7%Pe

rcen

tof

Non

-EIT

CR

ecip

ient

s14

.77%

10.5

7%18

.61%

48.1

6%4.

91%

2.99

%10

0.00

%

Not

es:

Hou

seho

ldda

taco

nstr

ucte

dus

ing

2008

CPS

;16

–64-

year

-old

s,20

08do

llars

.M

eans

are

wei

ghte

dus

ing

the

hous

ehol

dw

eigh

t“h

hwt.”


Much of the variation in the EITC across household types is becauseof differences in annual income. Not surprisingly, married households earnmore than single households since there is the potential for two earners. It isinteresting to note, however, that the share of married households that havetwo earners is quite low for EITC recipients, compared to non-recipients. Forexample, approximately 30 percent of married households with two childrenwho receive the EITC have two earners, while 71 percent of non-recipientshave two earners. This could be due to the fact that the majority of two-earnerhouseholds surpass the income qualifications of the EITC. Or, it could be thatEITC-recipient households choose not to have a second income since theyreceive the EITC.

Another interesting feature is that household earnings for EITC recipientsincrease with the number of children, and this occurs for both married couplehouseholds and single parent households. The difference in annual incomebetween childless households and households with children is much larger forEITC-recipient households than for non-recipient households.

Even though single households that receive the EITC earn less than mar-ried households, they tend to be more educated (for married households, weuse the education level of the household head). Approximately 10 percentfewer single households have a high school degree or less compared to mar-ried households and this is independent of the number of children. This is notthe case for non-recipient households: Single households that do not receivethe EITC are more likely to only have a high school education than marriedhouseholds.

Thus, the EITC likely has the largest impact on households with childrensince the EITC is much larger for these households as a share of their annualincome and more than 75 percent of EITC recipient households have chil-dren. Single households represent the majority (60 percent) of EITC recipienthouseholds, and tend to be more educated than married EITC households,which contrasts with the general population. EITC recipient households aremuch less likely to have two earners than non-recipient households.

4. EITC AND INCOME BY AGE

We now analyze how the EITC changes across recipients of different ages.Since the EITC targets low-income families, it will disproportionately affectyounger households of child-rearing age. However, households may qualifyfor the EITC at any stage of their life, as long as they have earned incomethat is below the income limit. Importantly, there is no limit to the amount ofbenefits received over a lifetime nor is there a time limit.

We analyze the pool of EITC recipients between 1992–2008 and cataloghow the EITC varies across households of different ages in a shortened panel.Specifically, we estimate the average income/EITC (in 2008 dollars) for each


household at each age in each year of the CPS (using the household weightssupplied by the CPS). Then, we calculate the average income/EITC across thepanel by age; to do this, we account for the distribution of households at eachage across the panel. This yields an estimate for income/EITC, conditionalon receiving EITC, at each stage in the lifecycle for the typical household inthe CPS.

While the preceding is useful, it is an imperfect measure of the effect ofEITC on lifetime earnings. It abstracts from any cyclical effects that individu-als experience in earnings (such as business cycles, changes in skill premium,or occupational transitions) that occurred prior to 1992 for older cohorts (forexample, changes in earnings profiles for individuals born before 1974 arenot accounted for prior to 1992). However, our method accurately accountsfor the drastic changes that occurred in the EITC during this period. In addi-tion, our estimates provide a sense of how the EITC changes by age and whathouseholds can expect as they age, should they qualify at later dates.

In Figure 2a, we plot the average EITC for households that receive theEITC at each age between 18–64 using 1992–2008 CPS data (the age of thehousehold head is used); we also plot the EITC as a percent of earnings (laborearnings and EITC) in the same figure. A few interesting findings emerge.The EITC is high for households headed by very young adults (age 18–25),relatively constant for households in their thirties (at approximately $2,000 in2008 dollars), and then declines precipitously as we look at households in theirlate thirties and beyond. By the time households are in their fifties and sixties,the average amount of EITC is just over $500. Thus, the amount of EITC thathouseholds receive declines over the course of their lifetimes. However, theinteraction of the qualification requirements and the structure of benefits ensurethat the EITC remains a relatively constant fraction of recipients’ earnings,at approximately 15 percent, for most of their lives. While the typical EITCtransfer is largest for the youngest recipients in our sample, the EITC representsa significant fraction of annual earnings (at least 15 percent) throughout mostof a recipient’s working life. In addition, the EITC represents an even largerproportion of the income of older EITC recipient households. For example, forEITC recipients in their late fifties, the EITC increases as a percent of earningsto approximately 18 percent. This is likely due to the fact that households thatqualify for the EITC at this age have very low incomes since they likely facethe income thresholds applicable to those with no children.

The patterns in EITC receipt across different age groups arise from twofactors: child-rearing stages and fluctuations in income over the lifetime. Atypical lifetime earnings profile exhibits a hump shape, where earnings arelow early in life, increase dramatically through the twenties and thirties, leveloff through the forties, and start to decline in the fifties and sixties. Thisis exactly what we observe for non-EITC recipient households in the CPSsample. In Figure 2b, we plot household earnings (wages and salary) profiles


Figure 2 EITC Recipients and Non-Recipients Across Ages

Panel A: EITC over the Lifecycle for Recipient Households

Panel B: Lifecycle Income with and without the EITC

EITC

EITC as a Percent of Income

EIT

C (2

008$

)

Age

EITC

as a Percent of Incom

e

2,500

2,000

1,500

1,000

500

0

18 23 28 33 38 43 48 53 58 63

25.00%

20.00%

15.00%

10.00%

5.00%

0.00%

Income for EITC Recipients

Income for Non-EITC RecipientsIncome + EITC for EITC Recipients

Age

18 23 28 33 38 43 48 53 58 63

Inco

me

(200

8$)

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

Notes: Household data constructed using 1992–2008 CPS; 16–64-year-olds, 2008 dollars.Means are weighted using the CPS household weight “hhwt.”

for non-EITC recipients and EITC recipients. By construction of the eligibilityrequirements for EITC, however, those receiving it at various ages are muchmore similar to each other than are non-recipients of differing ages. Amongstrecipients, the highest levels of benefits accrue to the young, typically aroundage 25. Older recipients generally earn smaller amounts, primarily as thenumber of dependents they may claim falls.


5. MARGINAL INCOME TAX RATES

The EITC represents a negative income tax for households that qualify forit. Thus, for low income levels, marginal income tax rates are negative. Us-ing data from TAXSIM version 9.0 from the National Bureau of EconomicResearch,5 we calculate the marginal income tax rates for all single and mar-ried households with no children, one child, and two children (i.e., dependentsexemptions) for tax year 2008.6 The marginal income tax rate is for adjustedgross income only and does not include Federal Insurance Contributions Act(FICA) contributions (i.e., Social Security and Medicaid).

In Figure 3, we plot the marginal tax rates across income levels for singleand married filing status earning up to $100,000 and differentiate householdsbased on the number of children they claim as dependents. As you can seein the first panel for married households with two or more children, for lowlevels of income, the marginal tax rate is −40 percent for both single and mar-ried filers, which represents the phase-in rate for the EITC. As incomes reach$13,000, the marginal rate is 0 percent (in the plateau region). For householdswith income above $13,000, the marginal tax rate becomes positive and getsquite large quickly. For married households with incomes between approx-imately $19,000–$25,000, the marginal tax rate jumps to 21 percent, whichrepresents the EITC phase-out rate. That is, at the margin, these householdsare experiencing a 21 percent reduction in their EITC for any additional in-come they earn in this range. For married households with incomes betweenapproximately $25,000–$40,000, the marginal income tax rate increases to31 percent, which represents the EITC phase-out rate plus the lowest incometax bracket of 10 percent. For married households with two children earning$41,000, they face the phase-out rate and the next highest tax bracket of 15percent, making their marginal tax rate 36 percent. Thus, the phasing outof the EITC leads to dramatic increases in the marginal income tax rates forthese households. For married households above $41,000, they no longerqualify for the EITC; hence, they face significant reduction in their marginaltax rates, at 15 percent (in the second income tax bracket). As householdincome approaches $90,000, the marginal tax rate increases to 25 percent formarried filers.7,8 Single taxpayers with two children experience similar jumpsin the marginal income tax rates, but for lower levels of income than marriedhouseholds.

5 www.nber.org/˜taxsim/taxsim-calc9/index.html.6 We follow the methodology of Hotz and Scholz (2003), Romich (2006), and Eissa and

Hoynes (2009) in generating the marginal tax rate schedule.7 Marginal tax rates in the United States increase up to 35 percent for household incomes

up to $357,000 (in 2008). However, we focus on income tax rates for low- and middle-incomehouseholds.

8 If we were to include FICA contributions, the entire marginal tax curve would shift upwardby 7.65 percentage points across all income levels.


Figure 3 Marginal Income Tax Rates

Panel 1: Households with Two Children

Panel 3: Households with No Children

Panel 2: Households with One Child

Married

Single

Married

Single

Married

Single

Mar

gina

l Tax

Rat

e (%

)

Mar

gina

l Tax

Rat

e (%

)

Mar

gina

l Tax

Rat

e (%

)

Income

40

30

20

10

0

-10

-20

-30

-40

40

30

20

10

0

-10

-20

-30

-40

40

30

20

10

0

-10

-20

-30

-40

10,0

000

20,0

00

30,0

00

40,0

00

50,0

00

60,0

00

70,0

00

80,0

00

90,0

00

100,

000

Income

10,0

000

20,0

00

30,0

00

40,0

00

50,0

00

60,0

00

70,0

00

80,0

00

90,0

00

100,

000

Income

10,0

000

20,0

00

30,0

00

40,0

00

50,0

00

60,0

00

70,0

00

80,0

00

90,0

00

100,

000

Source: TAXSIM 9.0, 2008 tax year.

The second panel in Figure 3 shows the marginal income tax schedulefor married and single households with one child. The figure is similar forthose with two or more children, however, the marginal rates are slightly loweracross all income levels. For example, the poorest households with one childface a marginal tax rate of −34 percent (compared to 40 percent for householdswith two or more children). In addition, marginal tax rates for those earningbetween $20,000–$40,000 are approximately 5 percentage points lower forthose with one child, because of differences in the slope of the phase-out rate(the phase-out rate is steeper for those with more children, as documentedin Table 2). As households go beyond EITC eligibility, the marginal incometax schedule does not vary with the number of children. Once again, these


households experience significant reductions in their marginal tax rates assoon as they are ineligible for the EITC.

In the last panel of Figure 3, the income tax schedule is quite different forthose with no children compared to those with children. Recall that the EITCis much less generous for childless households. Thus, the negative marginalrates are quite low (in absolute value terms) for the poorest households. Alsonotice that the increases in the marginal rates are not as extreme for childlesssingles; as a result, these households do not experience significant reductionsin their marginal tax rates as they become ineligible for the EITC (for incomesabove $15,800 for married households). Beyond EITC eligibility, they facethe same marginal income tax rates as households with children.

Our analysis of the marginal income tax schedule for EITC recipientsuncovers a few interesting points. First, the very poorest households withchildren (those earning below $12,000) experience large negative income taxrates (in absolute value terms) because of the EITC. Second, single parenthouseholds that receive the EITC face some of the highest (positive) marginalincome tax rates in the United States (Ellwood and Liebman 2000); for ex-ample, a single mother with two children earning $35,000 pays a marginalincome tax rate of 36 percent (in 2008). These high marginal tax rates canbe attributed to the phasing out of the EITC and the progressive income taxschedule (Romich 2006). Married households with children face slightlylower marginal tax rates than single households with children. Third, oncehouseholds with children no longer qualify for the EITC, their marginal incometax rates drop significantly, and once they surpass EITC eligibility, marginalincome tax rates no longer depend on the number of children in the household.

6. LABOR SUPPLY RESPONSE TO EITC

As a wage subsidy, the EITC has the potential to affect both the decisionto work (i.e., the extensive margin) and the number of hours worked (theintensive margin). In a static labor-leisure model, the EITC increases themarginal value of working (i.e., the after-tax wage rate). Thus, in theory,the EITC will increase labor market participation because of the substitutionof work for leisure. However, the effects of the EITC on hours worked aretheoretically ambiguous. We follow the formulation in Eissa and Hoynes(2009) in extending the labor-leisure model to include the EITC.

Consider a representative household within the traditional labor-leisuremodel, where the household unit decides how much to work. The house-hold could constitute one or more workers, where the tradeoff to working ishousehold leisure. The budget constraint (without the EITC) is depicted by:c = w̃ ∗ n, where c represents consumption, w̃ represents after-tax wages,and n represents labor hours. Households have T units of time to devote tolabor (n) and leisure (l); T = n + l. The slope of the budget constraint, and


hence the cost of pursuing an additional unit of leisure, is w̃ units of consump-tion. In Figure 4a, we plot the budget constraint with leisure on the x-axisand consumption on the y-axis (BLA). Plotting an indifference curve on thisgraph (with all of the standard assumptions for utility) provides the equilib-rium quantity of leisure (lA) and consumption (cA), at point A. If after-taxwages rise because of a reduction in the marginal income tax rate, the budgetline gets steeper (rotates to BLB). For the same household, the equilibriumquantity of leisure/labor may rise or fall because of the tax cut. The substitu-tion effect reduces leisure, and hence raises labor supply. The income effectraises leisure and lowers labor. The net effect depends on the relative sizeof each effect. In the diagram, the income effect dominates such that laborsupply falls (leisure increases) in response to a tax cut (lB > lA).

The EITC changes the after-tax wage rate (w̃) for different levels ofleisure/labor. For low levels of labor, when the household receives a taxcredit (i.e., a negative tax) for each additional unit of labor, the after-tax wageis w̃ = w (1 + ts), where ts > 0 is the phase-in rate. For higher levels of laborin the plateau region, the after-tax wage is simply w since the EITC is constantin this range; that is, w̃ = w where households receive a transfer, T r . Duringthe phase-out region, the after-tax wage is w̃ = w

(1 − tp

); the EITC falls for

each additional unit of labor at the rate tp > 0. For very high levels of labor,the after-tax wage returns to w once again. Thus, the budget constraint is asfollows: c = w

(1 + τp

)∗n for n ∈ (0, n1); c = w ∗n+T r for n ∈ [n1, n2);c = w (1 − ts) ∗ n for n ∈ [n2, n3); c = w ∗ n for n ∈ [n3, T ); where T r isthe maximum EITC and ni represents different quantities of labor. The EITCbudget constraint, as plotted in Figure 4b, is kinked at each quantity of laborni in which w̃ changes.

By comparing the budget constraint with and without the EITC in thevarious ranges of labor supply, we can determine the theoretical effects ofthe EITC on hours worked. First notice that for households that do not work(l = T ), the EITC is 0 and has no effect on the household’s budget constraint.However, for those households that choose to work very little (i.e., n = ε,where ε ∈ (0, n1)), the slope of the budget line gets steeper. Here, thereis a positive substitution effect and no income effect. Thus, the EITC mayinfluence some households to enter the labor force, leading to a positive effecton the extensive margin.

However, the effects of the EITC on the intensive margin are more com-plicated. In the phase-in range, the slope of the budget constraint is higherwith the EITC (w̃ > w since ts > 0); thus, a negative income effect and a pos-itive substitution effect are both at play, making the effects on hours workedambiguous. Those in the plateau region receive the same amount of credit ifthey earn more income, and hence a pure income effect occurs in which higherincome reduces the incentive to work. In the phase-out range, the slope ofthe budget constraint is flatter than without the EITC (w̃ < w since tp > 0).


Figure 4 EITC and Labor Supply

Panel A: Labor-Leisure Model without the EITC

Consumption (c)

BA

cB

cA

B

A

ICB

ICABLB

BLA

l l Leisure (l)

Panel B: Budget Constraints with and without the EITC

Consumption (c)

Budget constraint without EITC

Budget constraint with EITC

Leisure (l)n 123 n n

Here, a negative substitution effect influences households to substitute leisurefor hours worked. In addition, a negative income effect may reduce hoursworked even more. Thus, households in the phase-out region unambiguouslyreduce hours worked. Since a majority of EITC recipient households fall inthe flat or phase-out region, it is likely that the overall effects of the EITC onhours worked are negative (Hotz and Scholz 2003). For those with incomebeyond the phase-out region (n ∈ [n3, T )), their return to an additional hourof work is w, so that some of them may choose to restrict labor hours to beeligible for the EITC, once again leading to a negative extensive margin effect.


Of course, the magnitude of these responses depends on the elasticitiesof labor supply. High elasticities lead to larger labor supply responses, andlabor supply elasticities vary across different types of people. For example,the uncompensated elasticity of labor supply is higher for women than for menand the elasticity on labor force participation is larger than the elasticity ofhours (Evers, Mooij, and Van Vuuren 2008). Thus, the quantitative effects ofthe EITC on both the extensive and intensive margins of labor supply decisionsdepend critically on the presumed elasticities of labor supply.

There is a large empirical literature that examines the effects of the EITCon labor supply, with most of the work focusing on single mothers. For a moredetailed summary of this literature, refer to Holt (2006) and Hotz and Scholz(2003). The evidence indicates that the EITC does in fact increase labor forceparticipation, especially for single mothers (Meyer 2001), leading to positiveeffects on the extensive margin. In fact, the EITC has led to a dramaticincrease in employment rates for single mothers during the 1980s and 1990s(Eissa and Leibman 1996; Meyer 2001; Grogger 2004). However, the effectsof the EITC on the intensive margin are less clear in the data, with most studiesnot finding a significant change in hours worked because of the EITC. Themost relevant work here is that of Cancian and Levinson (2005), who studya natural experiment arising from the fact that one U.S. state (Wisconsin)altered the generosity of its matching of the federal EITC. They argue thatthere is essentially zero effect on hours. There is some evidence, however,suggesting that single mothers may work more in response to the EITC sincethey are likely to be in the phase-in region where marginal income tax rates arenegative (Eissa and Liebman 1996). Married women, however, who typicallyfall in the phase-out range, may work fewer hours as a result of the EITC rates(Ellwood 2000; Eissa and Hoynes 2004).

Very few studies analyze the labor market effects of the EITC on marriedcouples; notable exceptions include Eissa and Hoynes (2004, 2009). They findthat the EITC has small negative effects on both the extensive and intensivemargins for married couples. However, the EITC has differential effects onprimary and secondary earners. For example, increases in the EITC lowerboth the participation rates and hours worked for secondary earners sincethese households are usually being phased out of the EITC, where the returnsto working more are relatively low.

There seems to be some consensus in the empirical literature that theEITC has positive effects on the extensive margin for households and little tono effect on the intensive margin. Studies have shown that the labor supply oflow-income households is generally unresponsive to high marginal tax rates(Keane and Moffitt 1998; Gruber and Saez 2002); this compares to high-income workers who are quite responsive to tax rates. Perhaps low-incomeworkers cannot adjust their work hours because of their job structure (Romich2006). Or perhaps these workers do not realize the high marginal tax rates


because of the complexity of the income tax and benefits structure in the UnitedStates. Recent theoretical work in a separate but related context suggests thata central force may be that low-income households are typically low-wealthhouseholds. As a result, these households will often be close to a borrowingconstraint. Consumption theory predicts that such households will work in amanner insensitive to current wages, as the value of lowering the likelihood of abinding borrowing limit (by working and reducing consumption) will be high.The work of Pijoan-Mas (2006) suggests that this may be exactly the case, as heis able to rationalize a relatively high willingness of households to substitutelabor intertemporally, with a low aggregate correlation between wages andhours. In ongoing work, Athreya, Reilly, and Simpson (2010) utilize thisinsight and embed households into a setting in which they face uninsurablerisks and liquidity constraints, and find that, indeed, the disincentives to laborsupply arising from the EITC are not strong.

7. WEALTH DISTRIBUTION OF EITC RECIPIENTS

As documented above, EITC recipients earn much less over their lifetimesthan the general population. This will have important effects on their wealthholdings. In addition, their wealth level may affect their labor supply decision,as discussed above. In this section, we use the 2007 SCF to compare thedistribution of wealth for EITC recipients and non-recipients, and then analyzedifferences across the six different types of households. Wealth is defined ashousehold net worth, which is the difference between total assets and totaldebt.9 The SCF does not report anything related to the EITC. However, wecalculate the imputed EITC level that households would have received in taxyear 2006 using the household structure and wage/salary income reported bythe SCF. That is, we feed the parameters of the federal EITC program into theSCF to generate a proxy for the amount of EITC each household is eligibleto receive. However, it should be made clear that we cannot observe directlyif each household received the EITC—we know only whether or not theyqualified for the EITC and, if they qualified, how much EITC they shouldhave received.

All of the usual caveats apply when using the SCF data, in that it is a smallsample and is not representative of the U.S. population at large. Our sampleof the 2007 SCF contains 3,458 households compared to 86,259 householdsin the 2008 CPS (recall that we restrict the analysis to household heads be-tween 16 and 64 years old and use the individual-level data in the CPS tocreate household-level observations). It is well-known that the SCF over-samples wealthy and married households. For example, when comparing the

9 We use the SCF definition of net worth, as used in various Federal Reserve Bulletin articles,including Bucks et al. (2009).


distribution of household types between the CPS (reported in Table 4b) andthe SCF (in Table 5b), it is evident that married households are oversampledin the SCF compared to the CPS and that single households are undersampled(and especially childless singles and single parents with one child). Surpris-ingly, the SCF just slightly oversamples households that are eligible for theEITC; they represent 12.8 percent of the CPS sample and 16.4 percent of theSCF sample. Also, the SCF does surprising well in capturing an accuratedistribution of EITC recipients across household types and their mean incomeand EITC levels, compared to the CPS. This provides support to our use ofthe SCF to analyze EITC recipients. All of the reported means are reportedin 2007 dollars and are weighted using the replicate weights produced by theSCF.10

In Table 5a, we report mean net worth (i.e., wealth), assets, debt, andincome across household types. Not surprisingly, households that qualify forthe EITC have much less net worth, assets, and debt than non-recipient house-holds, and the difference is astounding. Mean net worth of EITC recipients is$103,753 (in 2007 dollars) compared to $580,245 for non-recipients. Some ofthe difference in net worth between EITC and non-EITC recipients can be ex-plained by differences in income and age: EITC recipients earn 23 percent ofwhat non-recipients earn, on average, and are almost six years younger. Some-what interesting is that mean debt level for EITC recipients is $45,755, whichrepresents 2.6 times their annual salary, compared to non-recipients whosedebt-to-income ratio is approximately 1.7. Thus, debt-to-income ratios arequite high for households that qualify for the EITC.

In Table 6, we report mean wealth by quartiles for both EITC and non-EITC recipients. First, notice that households in the lowest quartile of EITCrecipients have average negative wealth of −$16,617. In fact, 18.4 percentof households in the EITC sample have negative net worth. However, thereis a significant amount of heterogeneity in the first quartile, as evidenced bythe large standard deviation. This compares to the lowest quartile of non-EITC recipients, whose mean wealth level is $1,899 and standard deviation is$324. Second, notice that the wealth distribution for EITC recipients is muchtighter than for non-recipients. The ranges of wealth in each quartile are muchsmaller and the standard deviations are generally lower (with the exception ofthe first quartile of EITC recipients). Third, the majority of EITC recipientshold very little wealth; those in the third quartile of wealth hold on averageonly $24,038 in net worth, compared to non-recipients in the third quartilewho hold more than $250,000. Only the top quartile of EITC recipients has asignificant amount of wealth. In fact, only 20.3 percent of EITC recipients

10 For a full discussion of the importance of weights in the SCF, refer to Kennickell (1999).


Tabl

e5

Bal

ance

Shee

tsof

EIT

CR

ecip

ient

san

dN

on-R

ecip

ient

s

5a:

Ass

ets,

Deb

t,an

dN

etW

orth

ofE

ITC

Rec

ipie

ntvs

.N

on-R

ecip

ient

Hou

seho

lds

Mar

ried

,M

arri

ed,

Mar

ried

,Si

ngle

,Si

ngle

,Si

ngle

,A

llN

oK

ids

One

Kid

Tw

o+K

ids

No

Kid

sO

neK

idT

wo+

Kid

sE

ITC

Rec

ipie

nts:

Mea

nN

etW

orth

$103

,753

$284

,403

$204

,918

$118

,468

$67,

574

$56,

102

$49,

837

Mea

nA

sset

s$1

49,5

07$3

59,9

63$2

55,2

39$1

79,0

50$8

6,54

5$8

9,36

5$9

6,46

5M

ean

Deb

t$4

5,75

5$7

5,56

0$5

0,32

1$6

0,58

2$1

8,97

1$3

3,26

3$4

6,62

8M

ean

Hou

seho

ldIn

com

e$1

7,59

3$6

,199

$21,

818

$22,

502

$6,9

90$1

8,90

3$1

9,07

0M

ean

(Im

pute

d)E

ITC

$1,7

78$2

31$1

,440

$2,4

09$2

77$1

,720

$2,7

26M

ean

Age

38.5

46.6

37.2

37.5

37.1

40.4

38.1

Non

-EIT

CR

ecip

ient

s:M

ean

Net

Wor

th$5

80,2

45$8

03,4

47$6

21,3

45$7

37,6

54$2

75,4

37$3

51,4

16$2

23,3

09M

ean

Ass

ets

$708

,564

$929

,270

$790

,176

$933

,762

$334

,930

$448

,206

$296

,280

Mea

nD

ebt

$128

,319

$125

,823

$168

,830

$196

,108

$59,

493

$96,

790

$72,

971

Mea

nH

ouse

hold

Inco

me

$76,

686

$87,

916

$95,

962

$105

,640

$38,

071

$50,

373

$35,

849

Mea

nA

ge44

.346

.943

.641

.344

.847

.241

.5

5b:

Dis

trib

utio

nof

Hou

seho

lds

inth

eSC

FM

arri

ed,

Mar

ried

,M

arri

ed,

Sing

le,

Sing

le,

Sing

le,

No

Kid

sO

neK

idT

wo+

Kid

sN

oK

ids

One

Kid

Tw

o+K

ids

Sum

EIT

CR

ecip

ient

s:Pe

rcen

tof

All

Hou

seho

lds

0.97

%2.

20%

4.88

%2.

53%

2.46

%3.

38%

16.4

2%Pe

rcen

tof

EIT

CR

ecip

ient

s5.

9%13

.4%

29.7

%15

.4%

15.0

%20

.6%

100.

00%

Non

-EIT

CR

ecip

ient

sPe

rcen

tof

All

Hou

seho

lds

25.4

7%12

.66%

22.6

8%17

.42%

2.83

%2.

52%

83.5

8%Pe

rcen

tof

Non

-EIT

CR

ecip

ient

s30

.47%

15.1

5%27

.13%

20.8

4%3.

39%

3.02

%10

0.00

%

Sour

ce:

Aut

hors

’ca

lcul

atio

nsus

ing

the

2007

SCF.

Mea

nsar

ew

eigh

ted,

in20

07$.


hold more than the average wealth level for EITC recipients ($103,753). Thiscompares to non-recipients, where 41 percent hold more than the averagewealth level of $580,245 and 69 percent have more wealth than the averageEITC recipient.

There is significant variation in wealth across household types, as illus-trated in Table 5a. Married households have three times as much wealth assingle households, with the largest difference for households with no chil-dren. It is likely that most of the wealth held by married households with nochildren is comprised of housing wealth since this group is relatively old. Inaddition, mean household wealth is smaller for households with more childrendespite higher earnings, and this effect is particularly large for married house-holds. Thus, mean wealth levels for single households are quite low but arenot that different for those with and without children. For married households,households with children have higher earnings but significantly less wealthcompared to those without children. This is partially explained by age differ-ences across married households—those without children are approximatelynine years older than those with children. In addition, single households with-out children earn the least income of any group, but are not the poorest type ofhousehold in terms of net worth. Single households with two or more childrenhave the lowest net worth in both the EITC and non-recipient samples.

Our analysis documents several interesting findings about the wealth hold-ings of EITC recipients. Not surprisingly, we find that EITC recipients holdvery little wealth: EITC recipients, on average, hold only one-fifth of thewealth of non-EITC recipients. In fact, the bottom quartile of EITC recipientshold negative wealth on average, while the bottom quartile of non-recipienthouseholds have small, positive wealth holdings. However, debt-to-incomeratios of EITC households are significantly higher than those of non-recipients(2.6 compared to 1.7 on average). We find that married households that areeligible for the EITC hold more wealth than single households, and wealthholdings decrease with the number of children in the household.

8. EITC AND CREDIT CONSTRAINTS

Based on the data presented in Figure 2b, the EITC increases earnings forrecipients during every year of their working life and more so in early life.In a typical lifecycle model of savings and consumption, a household wouldsave in periods when income is high, and borrow when income is low. Asa result, the EITC allows low-income families to smooth consumption overtheir lifetimes. At higher frequencies, such as within a given year, the EITCcan help, even though most families receive the EITC in lump sum when they


Tabl

e6

Wea

lth

Dis

trib

utio

ns:

EIT

CR

ecip

ient

svs

.N

on-R

ecip

ient

s

Mea

nSt

.D

ev.

Min

.M

ax.

Mea

nM

ean

Inco

me

Age

EIT

CR

ecip

ient

s:B

otto

mQ

uart

ile−$

16,6

17$1

,860

−$47

3,70

0$1

70$1

4,93

834

.0L

ower

Mid

dle

Qua

rtile

$3,4

89$8

5$1

90$7

,560

$15,

919

33.7

Upp

erM

iddl

eQ

uart

ile$2

4,03

8$5

31$7

,630

$51,

400

$20,

507

38.6

Upp

erQ

uart

ile$4

04,2

72$2

4,21

5$5

2,12

0$6

15,0

00,0

00$1

9,01

447

.7N

on-E

ITC

Rec

ipie

nts:

Bot

tom

Qua

rtile

$1,8

99$3

24−$

118,

999

$24,

120

$34,

055

37.9

Low

erM

iddl

eQ

uart

ile$7

5,32

9$6

97$2

4,13

0$1

41,5

00$5

1,82

942

.6U

pper

Mid

dle

Qua

rtile

$253

,637

$1,4

67$1

41,5

20$3

96,2

10$7

6,59

946

.5U

pper

Qua

rtile

$1,9

91,1

97$3

3,64

6$3

96,3

00$8

06,0

00,0

00$1

44,3

0850

.4

Sour

ce:

Aut

hors

’ca

lcul

atio

nsus

ing

the

2007

SCF.

Mea

nsar

ew

eigh

ted,

in20

07do

llars

.


file their tax returns.11 In addition, households may borrow against their EITC,knowing that they will be receiving it later. Alternatively, households may savetheir EITC for future consumption.

The ability of households to smooth (bring forward) an expected EITClump-sum payment that is made at the time of one’s annual income tax pay-ment depends on the household’s ability to borrow. For those who can borrow,the EITC may act as insurance against income, employment, or health shocks,for example. If, on the other hand, households face significant borrowing con-straints, they may not be able to borrow against their EITC, and so, while theEITC still provides low frequency smoothing, it may not assist consumptionsmoothing efforts within shorter periods, for example one calendar year.

Direct evidence on the extent to which EITC recipients are credit con-strained is not possible, given current data limitations. Moreover, credit con-straints are generally very difficult to identify. Typically, the measurement ofcredit constraints in any given study relies on a particular theory of consump-tion to identify consumption or savings movements that appear “anomalous,”such as the large “excess sensitivity” literature on the 1980s for the path ofaggregate consumption (see Deaton 1992). A handful of articles find evi-dence that suggests that those who share demographic characteristics with theEITC recipients are likely to be credit constrained. For example, the resultsof Jappelli (1990) indicate that lower income, wealth, and age are all associ-ated with higher likelihoods of being credit constrained, all key features of theEITC population as documented above. Souleles (1999) finds that householdsthat receive tax refunds and are liquidity constrained experience significantincreases in nondurable consumption at the time of refund receipt. Barrowand McGranahan (2000) discover a seasonality of consumption behavior thatis consistent with the timing of the receipt of the EITC, especially for durablegoods. Berube et al. (2002) discuss the proliferation of paid tax preparationservices and refund loans (at relatively high interest rates) for EITC recipients,suggesting that these households lack financial services and, hence, access tocredit. Finally, Elliehausen (2005) analyzes survey data from households thatuse refund anticipation loans (RALs). He finds that EITC recipients whouse RALs are less likely to use various types of credit (including car loans,bank and retail credit cards, and mortgages) than other RAL households. Inaddition, Elliehausen (2005, 52) reports that:

Nearly half of EITC recipients that obtained RALs reported being turneddown or limited by a lender in the last five years, and a little morethan half said that they had thought about applying for credit but didnot because they thought that they would have been turned down. These

11 The advance EITC allows them to receive their EITC throughout the year in their paycheck,but very few households participate in this option (Romich and Weisner 2000).


percentages are more than two times the percentage of all householdsexperiencing turndowns or limitations and more than three times thepercentage of all households perceiving limitations in credit availability.

However, no study has provided direct evidence of the extent to which EITCrecipients are credit constrained.

Using 2007 SCF data and following Jappelli (1990), we use a set of ques-tions from the SCF that provide a sense of the severity of credit constraintsthat EITC recipient households face. We use the following four measures:

1. Bad credit: For households that do not have a checking account, theSCF asked why. If the response was because of credit problems,bankruptcy, and/or does not meet qualifications for an account, thena value of 1 was assigned.

2. Credit card balances: This is the total value of credit card balances heldby households. Credit card balances consist of the amount outstandingon all credit cards and revolving store accounts after the last payment.Balances do not include purchases made since the last account state-ment.

3. Late payment for 60+ days: This was assigned a value of 1 if thehousehold had any debt payments more than 60 days past due in thelast year.

4. Has no checking account: This was assigned a value of 1 if the house-hold did not have a checking account.

Certainly, these four measures are not perfect predictors of being creditconstrained. For example, some households choose not to have a checkingaccount for reasons that are unrelated to their credit status. However, nothaving a checking account will undoubtedly lead them to have less access tocredit in the future; without a checking account, many banks are not willingto issue personal loans and/or mortgages. That is, the causality between thesemeasures and the likelihood of being credit constrained is unclear; however,if we find some correlation between these measures and the EITC, it mayshed some light on the extent to which EITC households are or will be ableto borrow. Similarly, credit card balances are an imperfect measure of creditconstraints; lower balances may imply less willingness to use credit cardsand/or acquire debt, and not less ability to borrow. But it may also indicatethat they have lower credit limits, suggesting tighter borrowing constraints.Of the four measures above, having bad credit and late payments are perhapsthe most accurate measures of credit constraints since both will lead to lowercredit scores and, hence, worse credit terms.

In the analysis that follows, we compare these four measures for house-holds that receive the EITC versus non-recipient households. As we document


in Section 1, EITC-recipient households are younger, less educated, and havemore children than non-recipient households; as a result, they are poorer.Obviously, having fewer current and, especially, future resources to borrowagainst will make it more difficult for EITC-recipient households to borrow.Nonetheless, it is useful to know the extent to which any household is likelyto be constrained as suggested by the criteria above. We therefore do notcondition on all possible household characteristics since they would likelyexplain away any differences between EITC recipients and non-recipients.Instead, we attempt to document the extent to which households that fit theEITC profile face borrowing constraints.

In Table 7, we report the means and standard deviations of these fourmeasures for EITC recipients, non-recipients, and across household types.(Recall that EITC recipients in this context are defined as those who qualify forthe EITC.) EITC recipient households report being denied a checking accountbecause of bad credit more frequently than non-recipients (2.3 percent versus0.5 percent for non-recipients). They also have lower credit card balances($2,131 compared to $4,174); this could indicate that these households havelower credit limits, or are less willing to use acquire debt, or are less willingto use credit cards. EITC households are twice as likely to have late debtpayments as non-recipients (11.2 percent compared to 5.4 percent), whichwould lead to having less access to credit. In addition, EITC households arethree times more likely to not have a checking account (28 percent versus 7percent).

When looking across households types, we can see that several interestingfacts emerge. First, single households have lower credit card balances; theyare generally more likely to have late payments; and they are less likely to havea checking account than married households (holding constant the number ofchildren). However, the differences between single and married householdsare larger for non-recipients than for EITC recipients. For example, marriedhouseholds have much larger credit card balances than single households inthe non-EITC sample, but the difference is smaller for married and singleEITC recipients.

Second, married households with children that qualify for the EITC reportvery high late payment frequencies compared to their non-recipient counter-parts. Approximately 13 percent of married households with one child have alate repayment, compared to just 5 percent of non-recipients. We do not ob-serve significant differences between single-parent EITC recipients and non-recipients. Thus, EITC recipient households that are married with childrenwill undoubtedly have worse credit statuses and lower borrowing limits thantheir non-recipient counterparts.

Third, for married households, credit does not seem to be more restrictedfor those with more children. However, single households seem to be morecredit constrained as the number of children increases, and this is true for both


Tabl

e7

Mea

sure

sof

Bei

ngC

redi

tC

onst

rain

ed

7a:

Mea

sure

sof

Bei

ngC

redi

tC

onst

rain

ed:

EIT

CR

ecip

ient

svs

.N

on-R

ecip

ient

sM

ean

St.

Dev

.E

ITC

Rec

ipie

nts:

Bad

Cre

dit

2.3%

0.3%

Cre

dit

Car

dB

alan

ce(2

007$

)$2

,131

$140

Lat

ePa

ymen

tfo

r60

+D

ays

11.2

%0.

6%H

asN

oC

heck

ing

Acc

ount

27.9

%0.

9%N

on-E

ITC

Rec

ipie

nts:

Bad

Cre

dit

0.5%

0.1%

Cre

dit

Car

dB

alan

ce(2

007$

)$4

,174

$91

Lat

ePa

ymen

tfo

r60

+D

ays

5.4%

0.2%

Has

No

Che

ckin

gA

ccou

nt7.

0%0.

3%

7b:

Mea

sure

sof

Bei

ngC

redi

tC

onst

rain

edby

Hou

seho

ldT

ype

Mar

ried

,M

arri

ed,

Mar

ried

,Si

ngle

,Si

ngle

,Si

ngle

,N

oK

ids

One

Kid

Tw

o+K

ids

No

Kid

sO

neK

idT

wo+

Kid

sE

ITC

Rec

ipie

nts:

Bad

Cre

dit

0.0%

0.0%

2.2%

3.0%

3.3%

3.1%

Cre

dit

Car

dB

alan

ce(2

007$

)$2

,541

$2,9

66$2

,092

$2,4

19$1

,456

$1,9

33L

ate

Paym

ent

for

60+

Day

s1.

9%13

.6%

13.1

%7.

0%10

.8%

13.5

%H

asN

oC

heck

ing

Acc

ount

28.7

%25

.6%

25.7

%31

.6%

27.3

%29

.3%

Non

-EIT

CR

ecip

ient

s:B

adC

redi

t0.

2%0.

3%0.

0%1.

3%0.

0%1.

3%C

redi

tC

ard

Bal

ance

(200

7$)

$4,4

97$4

,946

$5,5

02$2

,693

$3,5

09$1

,401

Lat

ePa

ymen

tfo

r60

+D

ays

3.7%

3.9%

5.3%

6.5%

11.7

%8.

5%H

asN

oC

heck

ing

Acc

ount

5.0%

4.1%

2.1%

11.7

%13

.2%

25.7

%

Sour

ce:

Aut

hors

’ca

lcul

atio

nsus

ing

the

2007

SCF.

Mea

nsar

ew

eigh

ted.


EITC recipients and non-recipients. As documented above, the net worth ofsingle households falls as the number of children increases (from Table 5a).

Our analysis suggests that EITC recipients use credit markets differentlythan non-recipients, possibly as a direct consequence of their income beingcurrently and perhaps temporarily low, and this may have important implica-tions on their ability to borrow. For example, EITC recipients are less likely tohave a checking account and have lower credit card balances. They also morefrequently have late debt repayments and are denied checking accounts thannon-EITC recipients. Thus, it seems that at the time of receipt of the EITC,households are closer to limits on their ability to borrow than households thatdo not receive the EITC, and much of this is because of differences in incomeand household structure between the two groups.

9. CONCLUSION

In this article, we have studied several aspects of the Earned Income TaxCredit (EITC) that have been previously overlooked, including the incomeof EITC recipients at various ages, their wealth holdings, and the extent towhich they are credit constrained. Naturally, we find that average annualearnings for those who receive the EITC are much lower than for non-EITCrecipients at every age. In addition, younger households receive more EITC,and the amount of EITC received by these households suggests that the EITCincreases lifetime earnings non-negligibly. The EITC in all likelihood pro-vides a nontrivial mechanism for young, working households to smooth theirconsumption over their lifetimes.

The EITC acts as a negative income tax for recipient households. Specif-ically, we show that it has important implications on the marginal tax rate thatlow-income households face at various levels of earned income. Because ofthe phasing out of tax credits and income-support programs (such as TANF,food stamps, etc.), marginal income tax rates are much higher for low-incomehouseholds than for middle- and high-income households in the United States.In particular, the marginal tax rate is negative for low levels of income, veryhigh for those with moderate incomes that still qualify for the EITC, and thenfalls once households no longer qualify. We find that single-parent householdsthat receive the EITC face some of the highest marginal income tax rates inthe United States.

We then consider the theoretical and empirical effects of the EITC onthe extensive and intensive margins of household labor supply. The EITChas undoubtedly increased labor force participation, but the effects on hoursworked are ambiguous. This can be partly explained by the fact that low-income/low-wealth households that face borrowing constraints are insensitiveto changes in the returns to working. Existing empirical work supports thisconclusion.


Lastly, using data from the Survey of Consumer Finances, we estimatethe wealth distribution of EITC households and measure the extent to whichEITC households are credit constrained. Not surprisingly, we find that EITC-recipient households are very poor in terms of net worth: The average house-hold has less than 20 percent of the average wealth of the average non-recipienthousehold. In addition, EITC recipients are more likely to have bad credit andare more likely to have late debt payments than the average U.S. household,suggesting that they are more credit constrained.

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